Tuesday, February 16, 2010

So Scott Fulwiller and the rest of the Chartalist gang have been saying that bank lending is capital-constrained. Banks will not lend if they do not have the requisite capital.

Well, that just goes to show you how American banks are really a cut above all the rest. You see, American banks are NOT limited by capital constraints. Here are 6 reasons why:

1. Securitization Why do you need to extend loans to everyone asking for one when you can just originate them and pass them along to other holders? Why tie up your capital for 20 to 30 years when you can just be the intermediary crunching the loans and securitizing them to hungry investors? Here’s the thing. …extending loans and keeping them on the balance sheet—capital-eating. Originating and distributing an endless pipeline of loans and keeping the fees --capital accreting. You do the math.

And if one day, these originating banks will want to originate loans to bolster their own asset base, they can always provide a second mortgage to this existing base of clients. And should circumstances ever warrant that haircuts one day be necessary on haphazardly underwritten loans, having the second mortgage doesn’t necessarily mean they are subordinate. The originating banks can always bully their first lien holders (who bought the securitized loans) to take up some of the haircut, because after all, they can always say no. Take that first lien and shove it up you ass, moronic investors. Thank you yield-hungry investors.

2. SIVs Why do you need to put up capital when nobody knows you have such loans? So set up as many off balance sheet entities as you can, and make their inter-relationships obtuse and incomprehensible. Set them up offshore as much as possible. Thank you offshore corporate lawyers.

3. AAA-rated asset-backed securities Hey, if you happen to be one of the 2B2F banks, why even bother with the headaches of underwriting and monitoring hundreds of individual credit risks at all? Why not just get sliced and diced tranches of these securitized assets from the originators, and just buy up all the AAA-rated ones. How much of a capital risk weight will that be when all you’ve got are lots of AAA? Thank you S&P.

4. Mark-to-market accounting And hey, as long as you’ve got lots of securities on your balance sheet, look out for the capital appreciation made possible by your own investing activities. You’re 2B2F, when you go to market, you lift the market. Invest, mark-to-market, repeat. Then watch that capital grow. Thank you FASB.

5. Mark-to-model accounting And if you happen to be investing instead in illiquid securities, you can still mark them to your advantage. In fact, precisely since these securities are bespoke and not easily priced in the market, they have the best prospects of capital appreciation via mark to make believe. Thank you financial engineers.

6. Uncle Sam Well, if all these risk-taking activities end up biting you in the butt, and your capital is in danger of popping away like a bubble, why not double down? For all you know, the market will like the fact that you are supporting the market for your investments. And at the worst possible case, you know who really is the market maker of last resort, right? If you’re a member of the financial community of the world’s largest economy, the one that possesses the global default currency that can print as much money as it takes to prop you up, then who needs to really have all that capital just languishing your balance sheet? So thank you US taxpayers.

So while all the rest of the world’s banks have been busying themselves with endless rounds of equity capital raising, in the good ol’ US of A, there hasn’t really been any need. Bank capital raisingis for chumps. In the US, they DIVIDEND capital out. Take that, lesser mortals.

While it may be true that lending is capital-constrained for the rest of the world, over there, it is demand-constrained. Chuck Norris kick to you, Basel II. For as long as there is demand for loans, everybody come and get them. And in an economy that builds up capital due to the very act of lending and investing made possible by the banks, demand for loans will increase. You can say that there is a self-reinforcing mechanism at work here. In this environment, demand for loans can reach up to infinity.

Update: This is not a send-up of Scott's point, but a satire of certain bankers' mentality, as I explain in the comments.

6 comments:

Sadly, true. It's called "forbearance." Others call it "the bezzle," a term J. K. Galbraith coined in The Great Crash: 1929. It's short for embezzlement.

We are now in the Ponzi finance stage of the financial cycle that Hyman Minsky sets forth in his financial instability hypothesis. The next step is the implosion described in Irving Fisher's debt-deflation theory of depressions. Paul B. Farrell describes the unfolding situation at Market Watch here.

Would have been nice if you'd asked before implicating me, as I have no disagreement with any of your points you've made even though you set me out as the one you are trying to counter.

Also, note what I actually did write: "the bank must be aware of the impact on its capital requirements and other financial ratios with which the regulator is concerned." That would rather easily fit any of the caveats you raised here.

Scott, I wasn't implicating you at all. This is a tongue-in-cheek post, and the main takeaway I wanted to impart, is not so much that banks are not capital-constrained, but that some banks will try anything to get around these practical constraints (And we know where these bankers' efforts have brought all the rest of us)

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.